Friday, August 6, 2010

Automatic Data Processing (ADP) Dividend Stock Analysis

Automatic Data Processing, Inc. (ADP) provides technology-based outsourcing solutions to employers, and vehicle retailers and manufacturers. It operates in three segments: Employer Services, Professional Employer Organization Services, and Dealer Services. This dividend aristocrat has raised dividends for 35 consecutive years. Back in November 2009 Automatic Data Processing announced a 3% dividend increase.

Over the past decade this dividend stock has delivered an average total return of 1.20% annually. In 2007 ADP spun off its Brokerage Services business, distributing one share of Broadridge Financial (BR) common stock for every four shares of ADP common stock held by shareholders. The total returns calculation for ADP over the past decade includes this transaction.

The company has managed to deliver an 8.10% average annual increase in its EPS between 2000 and 2009. Analysts expect Automatic Data Processing to earn $2.40 share in FY 2010, followed by an increase to $2.55/share in FY 2011. While the employment picture is bleak in the US, it is improving. In addition to that, the market for payroll outsourcing for small and medium sized businesses could provide opportunities for growth, because of low penetration from outsourcers. The market for processing services that ADP specializes in is expected to grow at a pace of 5% per annum until 2013. The company's venture in the business process outsourcing is a bold move, considering the intense competition in this market segment, which could add pressure to margins. The market for business process outsourcing is expected to grow by almost 7% per year by 2013. Overall there is a high barrier to entry in the payroll processing field, since a sizeable investment in infrastructure is needed to process millions of employees' information. The big plus of this business is the recurring revenue stream and strong cash flow. ADP is a great proxy for exposure to the technology sector, since it has a proven business model, and it is less susceptible to technological obsolescence. As prices for technology products decrease, ADP can do its job cheaper, which helps profitability.

The Return on Equity has remained in a tight range between 17% and 26%. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

Annual dividends have increased by an average of 15.90% annually since 2000, which is higher than the growth in EPS. A 16 % growth in dividends translates into the dividend payment doubling every four and a half years. If we look at historical data, going as far back as 1974, Automatic Data Processing has indeed managed to double its dividend payment every four and a half years.

Over the past decade the dividend payout ratio has doubled to 50%. This is a direct result of the higher dividend growth in proportion to earnings growth. As the company matures, it has returned most of its earnings back to stockholders in the form of increased distributions and share buybacks. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently Automatic Data Processing is attractively valued at 15.60 times earnings, yields 3.20% and has an adequately covered dividend payment. In comparison to its closest competitor Paychex (PAYX), which trades at a P/E of 20.40 and yields 4.60% with a dividend payout ratio of 94%. I view ADP as more attractively valued. I would be looking forward to adding to my position in Automatic Data Processing (ADP) on dips.

Full Disclosure: Long ADP

Relevant Articles:

- Paychex (PAYX) Dividend Stock Analysis
- Eight Companies Rewarding investors with higher dividend payments
- 14 Dividend Stocks with Dividend Growth Potential
- Dividend Investing Works in All Markets

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